WEAKNESSES

Low productivity in extractive and manufacturing industries (excluding in the automotive sector)

Ongoing high non-performing loan ratio (15.6% in September 2017), putting pressure on the banks, 3/4 of which are foreign-owned

Strong euroisation of credit (67%)

Large informal economy and low female participation in the labour market

RISK ASSESSMENT

Growth sustained by internal demand

After a disappointing year in 2017, during which growth was adversely affected by a tough winter and then drought that successively hit construction, agriculture and electricity generation, 2018 should see regained momentum. It will, in particular, be driven by consumption. Households will benefit from rising wages, both in the private and public sector, a 5% increase in pensions on 1st January, more jobs and growth in credit, which is expected to get cheaper with key rates cut by 3.5% in October 2017. Thanks to budgetary margins, the administrations are expected to increase their purchases of goods and services. Public investment in the road, rail and irrigation networks will also benefit. While foreign investment in industry, construction and trade will continue, private domestic investment should finally benefit from the resumption of lending to businesses, even if credit will remain limited by the still high non-performing loan ratios, especially at the publicly-owned banks. Exports are expected to pick up momentum on their well-oriented markets, even if there are some concerns over future competitiveness due to the juxtaposition of the strong dinar and significant inflation. The central bank, aware of the economy’s strong euroisation, will maintain the dinar’s stability, preventing imported inflation from adding to the pressures generated by strong domestic demand and the robust labour market, as well as by higher energy prices. At the same time, imports will be fuelled by vigorous internal demand, cancelling out trade’s contribution to growth.

Fiscal consolidation to be continued

Under the three-year agreement signed with the IMF in February 2015, the authorities have succeeded in consolidating the budget resulting in balancing and easing the debt burden. They have been helped by the return to growth, which mechanistically boosts receipts. Benefitting from the margins thus generated, they will increase investment, pensions and civil service wages by up to 10% in education, healthcare, justice, the army and government finance, partially offsetting the cuts implemented in 2014. The expiry of the IMF agreement in early 2018 will raise questions about the long-term sustainability of the results, with much still to be done. Despite civil service staff cuts, the wage bill remains large. The budget balance rule is dated. The restructuring of many publicly-owned enterprises operating in the transport, energy, extraction and petrochemical sectors, in some cases prior to their privatisation or winding-up in the worst cases, is delayed. The workings of the administration leave much to be desired. Although the debt burden has eased, it is still significant with 75% denominated in dollars and in euros and 60% held by non-residents, over half of which are public sector creditors who have offered favourable terms. The authorities have moved to reduce the proportion held in foreign currencies by successfully refinancing it with dinar-denominated bond issues.

Current account deficit financed by FDIs

Trade in goods is running a deficit amounting to 9% of GDP (2016). Exports are dominated by automotive, agricultural products, metals and a wide variety of median to low value-added manufactured products for export primarily to the neighbouring Balkan countries. A large portion of the deficit is explained by imports associated with investments. Dividend and interest repatriation by foreign investors represents about 6% of GDP. The rise in these payments in 2018 plus higher imports will lead to a slight widening of the current account deficit. The services surplus (almost 3% of GDP, with tourism) and, in particular, remittances by emigrant workers (9%) will offset this in part. The remaining current account deficit is financed by foreign direct investments, in industry (e.g. Fiat plant in Kragujevac, two thirds of which is owned by the State, employs 10,000 people, provides 8% of exports and 3% of GDP) and in transport and energy infrastructure (China, Russia). Foreign exchange reserves represent 6 months of imports (September 2017) and together with a Swap agreement with China, guard against an exchange rate crisis, which would weaken an economy still heavily indebted in euro, despite the dinarisation underway. The external debt burden is easing (71% of GDP in late June 2017), as is that of public sector debt which accounts for 57% of the total.

Good relations with the West and with Russia

Early elections (as in 2014) in April 2016 returned the Progressive Party (SNS) to office with 57% of the seats. Aleksandar Vučić was replaced as Prime Minister by Ana Brnabic in July 2017, after his election as president. He continues to lead the SNS. In October 2017, there was talk of holding new early elections in early 2018, to coincide with the local elections, especially those being organised in Belgrade where the SNS has been losing ground. They will probably be won by the SNS against a disunited opposition. The business climate remains hampered by red tape, corruption and political interference. Negotiations regarding EU accession will continue, even if the normalisation of relations with Kosovo is delayed and those with Bosnia Herzegovina are complicated by the attitudes of the Bosnian Serbs. In addition, the country wants to cultivate good relations with both NATO and Russia.